Zynga presents obstacles to takeover

SPOTLIGHT ON TECHNOLOGY

Olga Kharif

Published 4:44 pm, Wednesday, August 22, 2012

Game maker Zynga's operations are getting the least credit in public markets among Internet media companies, and management's refusal to consider a sale as growth slows is blocking an avenue for shareholders to recoup losses.

With the stock dropping 70 percent since Zynga's December initial public offering, cash and investments represent 73 percent of the company's market value, the highest proportion among peers trading for more than $1 billion. Zynga shares are priced at 1.03 times sales, the worst valuation in the industry, after posting the third-biggest slump in the Russell 1000 index this year.

While Chief Executive Officer Mark Pincus, who controls 50.15 percent of the voting rights for Zynga shares, said in July that he'll never consider a sale, Ironfire Capital LLC says the biggest developer of games for Facebook's social network may draw the attention of activist shareholders pushing for changes.

The $2.26 billion company, which has dropped to $2.97 per share after second-quarter earnings missed analysts' projections last month, might fetch $7.30 per share in a takeover, according to Falcon Point Capital LLC.

"If they have an offer on the table, shareholders who have lost so much would welcome it," said Arvind Bhatia, an analyst at Sterne Agee & Leach Inc. in Dallas. He has the equivalent of a "hold" rating on the stock, along with at least 17 other analysts. Only six recommend buying.

Losses accelerate

"We remain focused on this sector to deliver an engaging social experience to our players, and to develop and create the best social gaming products in the industry," Dani Dudeck, a spokeswoman for the San Francisco game company, said when asked if it would consider a sale.

Losses in Zynga share value accelerated in July when the company reported lower second-quarter profit than analysts had forecast, saying changes to Facebook's site made it harder for users to find its games. Compared with the first three months of 2012, three of its top games - "FarmVille," "CityVille" and "CastleVille" - lost at least 20 percent of players, according to Bhatia, who cited AppData figures.

Zynga also cut its 2012 projection for bookings, a measure of sales of virtual goods. The company said earnings excluding some items will total 4 to 9 cents per share this year, down from a prior range of 23 to 29 cents.

A week after the quarterly report, people familiar with the matter said Chief Operating Officer John Schappert was stripped of his role overseeing game development amid a reorganization designed to revive growth and make more money from mobile services. Zynga announced Schappert's resignation Aug. 8.

"Given the reputation that management has garnered in only a short time as a public company, shareholders would likely have more near-term faith in the business if a change in control were to occur," said Evan Wilson, an analyst at Pacific Crest Securities Inc. in Portland, Ore.

Facebook's fate

Zynga is suffering along with Facebook, which has tumbled 50 percent since its IPO in May. A renewed emphasis on mobile games may help Zynga reduce its reliance on Menlo Park's Facebook, whose members account for about 80 percent of quarterly bookings, or the total value of goods sold in its games.

Zynga's ownership structure would be a hurdle for any takeover deal. As of July 23, Pincus owned shares giving him more than 50 percent of the voting rights, up from the 36 percent reported in the company's annual report in February. Its equity is split up into Class A, Class B and Class C shares, with the publicly traded Class A stock conveying the weakest voting rights.

Despite the concentration of ownership in the hands of Pincus and other insiders, activist investors may push for changes at the company, according to Eric Jackson, the founder of Ironfire Capital.

"It wouldn't surprise me if people started to do that at Zynga, because it's getting close to the value of cash," Jackson said.

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The company may still prove an attractive target for Activision Blizzard, Electronic Arts, Google, Microsoft and Sony, said Sean McGowan, an analyst at Needham. Asian companies such as Gree Inc., Nexon Co., Sina Corp. or Tencent Holdings Ltd. may also be interested. "I don't rule out the possibility of somebody being interested in them, but let's not forget that Mark Pincus controls the company," McGowan said.

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